Structuring and financing investment in cross-border residential real estate
Robert J Kiggins
Culhane Meadows, New York
rkiggins@cm.law
Report on session held at the IBA 2020 Virtually Together Conference
Friday 6 November 2020
Session co-moderators
Raul-Angelo Papotti Chiomenti, Milan
Sandy Bhogal Gibson, Dunn & Crutcher, London
Panellists
Daniel Bader Baer & Karrer, Zurich
Abel Francisco Mejía-Cosenza Sánchez Devanny, Queretar
Peter Murray Hall & Wilcox, Melbourne
Jennifer Smithson Macfarlanes, London
This panel discussed and presented slides on the tax and non-tax consequences of inbound and outbound cross-border investment in residential real estate through various structures in the following countries: Australia, Italy, Mexico, Switzerland and the United Kingdom.
The panel discussed several scenarios:
- individuals investing in residential real estate for commercial purposes;
- individuals investing in residential real estate for commercial purposes by a company resident in the asset jurisdiction;
- individuals investing in residential real estate for commercial purposes via a company resident in the individual’s jurisdiction;
- individuals investing via a fund in residential real estate; and
- individuals investing via a fund holding property in residential real estate.
Italy: by Raul-Angelo Papotti of Chiomenti, Milan
The presentation and slides on Italy focused on inbound transactions. The presenter discussed the first three items above but, instead of discussing the last two items, presented material on considerations for individuals investing via trust (resident in asset/foreign jurisdiction) in Italian residential real estate for commercial purposes. Depending on the scenario, non-tax considerations included factors such as administration costs, privacy concerns, protection from creditors and estate planning.
Tax considerations in each scenario were discussed for various phases of the life of an investment: acquisition, during the holding period and on disposal of the property. Each of these considerations were also matched to the scenario being discussed. Taxes covered included indirect taxes, income tax, and inheritance/gift tax (IHT). In addition, Italian corporate (CIT) and municipal (IMU and TASI) taxes were discussed and/or covered in the slides. The tax advantages of holding investments through an European Union vehicle in certain situations were also noted. Direct purchase of property by an individual followed by a contribution to a new or existing Italian resident investment company was noted as being potentially heavily taxed.
Switzerland: by Daniel Bader of Baer & Karrer, Zurich
The presentation and slides on Switzerland also focused on inbound transactions and covered all five scenarios. It was pointed out that scenarios three to five were not possible in Switzerland due to the so-called ‘Lex Koller’ applying. Lex Koller restricts the acquisition of Swiss real estate by foreigners. Foreigners may not acquire residential real estate in Switzerland for investment purposes. The restrictions apply to foreign individuals, foreign companies and even Swiss companies if they are not fully Swiss controlled. Therefore, scenarios three to five were noted as being generally excluded under Swiss law.
Non-tax considerations were explained for scenarios one and two. These scenarios were discussed as being possible under certain circumstances but still subject to Lex Koller limitations – although these limitations were presented as not being absolute bars on acquisition by non-Swiss individuals. Nuances in the different scenarios were presented. The key takeaway from a non-tax perspective was that the acquisition of residential real estate in Switzerland by foreigners is strongly restricted and possible structuring needs to be carefully analysed.
Different holding structures were discussed, and it was mentioned that the setup and administration of an investment company is relatively easy and fast. Tax considerations were given for each phase of the life of a permitted investment. On acquisition, the following was noted:
- tax items are registration/notary fees which usually are immaterial;
- real estate transfer taxes may apply but vary from canton to canton; and
- VAT does not apply in the case of residential real estate but might apply in the case of commercial real estate (a possible option).
An important note was that the real property serves as legal collateral for a seller's unpaid taxes in most cantons.
During the holding period, it was noted that the owner of the real estate is subject to limited tax liability in Switzerland (income and wealth tax for individuals, and CIT and capital tax for companies). The different taxation rules and possible tax deductions, which depend on whether the real estate is held as private or business assets, were explained.
On a subsequent disposal, the following was noted:
- real estate capital gains taxes (CGT) or CIT usually becomes due;
- the tax system varies from canton to canton;
- again, private and business assets are treated differently;
- social security contributions might be due if the real estate is held as business assets;
- IHT/gift tax can be relevant upon disposal if it is made for free or below market value;
- variations from canton to canton within Switzerland were noted, with some cantons not levying IHT/gift tax and other cantons having relatively high tax rates;
- during the holding period and upon sale, withholding tax (WHT) needs to be taken into consideration if the real estate is held via a company (WHT must be deducted by the company from the dividends paid to the shareholder); and
- treaty relief might possible, depending on the country/state of residence of the shareholder.
Australia: by Peter Murray of Hall & Wilcox, Melbourne
The presentation and slides on Australia covered both inbound and outbound transactions with regard to each of the five scenarios. In addition, a chart was included in the slides showing land taxes and duties in Australia for each of the seven Australian states and territories: the Australian Capital Territory, New South Wales, the Northern Territory, Queensland, South Australia, Tasmania, Victoria and Western Australia. The chart also identified where land tax and duty surcharges apply.
The presenter noted that duty is payable on the acquisition of real property, while land tax is an annual charge levied on the market value of land owned at 31 December of each year. It was noted that:
- non-tax considerations for inbound investment generally focused on restrictions on foreign investment administered by the Australian Foreign Investment Review Board (FIRB) as applicable depending on the scenario; and
- individuals are prohibited from purchasing existing property unless they are increase the housing stock in Australia – this increase will occur where an additional dwelling is built on the same land.
Nothing of note was reported for outbound non-tax considerations. Inbound tax consideration discussed by the presenter included:
- state taxes;
- franked (which permit a credit for corporate taxes already paid) and unfranked dividends;
- dividend withholding tax;
- goods and services tax (GST);
- income tax;
- vacancy fees;
- landholder duty;
- investment company taxes; and
- CGT.
The presenter commented that capital gain subject to tax is reduced by 50 per cent for an individual where the property is held for more than 12 months. The presenter also noted that no CGT discount applies to capital gains realised by a company. The presenter stated that a vacancy fee will be levied on a non-resident individual where property owned by that individual is not occupied or made available for rent for at least six months per year. It was explained that this is to ensure that property is made available to occupy, given the housing shortage in Australia.
Outbound taxes were explained as including income tax such as CGT with potential foreign income tax offset (FITO) and the potential application of Australia’s controlled foreign corporation (CFC) rules, which apply when property is held by a foreign company, the shares of which are owned by an Australian resident. There was also a presentation on special treatment for investments via Australian managed investment trusts (MITs).
Mexico: by Abel Francisco Mejía-Cosenza of Sánchez Devanny, Queretar
The presentation and slides on Mexico focused on inbound transactions as Mexico is typically a capital-importing jurisdiction. Scenarios one to three were discussed but, instead of scenarios four and five, material was presented on considerations for individuals investing via a Mexican Fideicomiso (trust) in Mexican residential real estate. This was noted as being the typical vehicle for foreign investors to participate in certain properties that are subject to a heightened regulatory burden. Some overall considerations were presented, such as:
- different types of Mexican real estate property – including private property, Ejido/communal property and restricted zone property – with the emphasis being made that acquirors should be extremely diligent in identifying and properly addressing the different legal issues pertaining to the different ownership formats;
- different types of ownership: individual, ownership through a Mexican Fideicomiso, or through a Mexican or foreign corporation; and
- major tax issues, including:
- the CGT capital gains rate versus ordinary gains rate;
- value-added tax (VAT);
- local real estate acquisition taxes that may vary from location to location;
- WHT on income derived by a foreign resident including on the sale or lease of the property,
- IHT that may make up as much as 25 per cent of the fair market value of property transferred at death to non-residents; and
- pension fund/transparent entities regimes that provide for generous exemptions for qualified parties, including not only for direct ownership but also through indirect ownership via a Mexican corporation and that apply to both gains on disposition as well as for lease income.
Non-tax considerations depending on the scenario as presented included:
- some restrictions on ownership in what is referred to as the ‘forbidden zone’ along international frontiers and coastal areas;
- certain formalities required by the Mexican law system, including personal comparison or formal powers of attorney being required and the involvement of authorised public notaries;
- public registry formalities and the priority system upon which it works to provide third party and creditor protections;
- title insurance not being generally used;
- business determination on whether a special purpose vehicle (SPV) or pension fund should acquire real estate directly or through a Mexican company, including the effects thereof on the application of diverse fiscal benefits under the numerous tax treaties executed by Mexico;
- the technical legal determination of the classification and characteristics of a SPV as a foreign legal entity or foreign legal person;
- pension funds;
- special restrictive legislation for Fideicomisos;
- the different types of Mexican Fideicomisos; and
- corporate and distribution rights not set forth in Mexican law, which are governed by contractual agreements and require bespoke negotiation and drafting.
The UK: by Jennifer Smithson of Macfarlanes, London
The presentation and slides on the UK covered both inbound and outbound transactions with regard to each of the five scenarios.
Non-tax considerations
No special UK considerations were noted for outbound transactions. As for inbound transactions, there is a public register of owners of residential properties as well as a ‘persons with significant control’ (PSC) regime that applies to UK incorporated companies, with the prospect of the register of owners of residential property being extended to beneficial owners via non-UK companies along the same lines of control as the PSC register for UK companies.
Taxes on acquisition
Little was noted in terms of UK tax on the acquisition of non-UK real estate by UK purchasers. For an inbound acquisition, the taxes payable on acquisition would be stamp duty land tax (SDLT) and potentially VAT. Stamp duty land tax is generally payable at a graduated rate depending on the purchase price of the property. The top rate of SDLT payable varies according to:
- the type of real estate (residential or commercial);
- the residence of the purchaser (non-resident purchasers being subject to a two per cent surcharge on residential property); and
- whether the purchaser either
- already owns one or more residential property (whether in the UK or abroad); or
- is not an individual, in which case a further three per cent surcharge may be payable unless the acquisition replaces the purchaser’s main home.
There are few exemptions or reliefs from SDLT. It was further explained that, where residential property is purchased through a company for any reason other than property development or rental to a third-party unrelated tenant, then a flat rate of SDLT of 15 per cent applies to all purchases over £500,000.
The acquisition of UK real estate is not usually subject to VAT (payable at 20 per cent) except where a specific election to charge VAT has been made by the vendor (which was noted as being very unusual in residential property purchases).
Purchase of residential property
On outbound transactions, it was noted by the presenter these included:
- distinctions between the deduction of trading assets and acquisition of a cost basis for capital assets;
- income tax rates;
- an anti-abuse rule;
- IHT considerations;
- the effect of domicile, depending on whether a UK or non-UK fund is involved if investment is through a fund;
- investment companies;
- CIT rates; and
- individual tax rates.
On inbound transactions, these were noted as including SDLT and VAT. The presenter commented that consequences can vary from scenario to scenario.
Taxes during holding period
The presenter made the following points:
- A UK-resident company will be liable to corporation tax on all profits arising in respect of any holding in foreign real estate;
- A UK-resident individual will be liable to UK tax in respect of non-UK property depending on their domicile;
- A UK-resident UK domiciliary will pay income tax on rental/property development income wherever situated, and the property will be within the scope of UK inheritance tax either on death, and in respect of any gifts made either into trust or in the seven years prior to death;
- A UK-resident non-UK domiciliary may be able to avoid paying UK income tax on rental/property development income from any non-UK property by claiming the benefit of ‘the remittance basis’ and ensuring the income is not brought to the UK. Similarly, non-UK real estate owned by a UK resident non-UK domiciliary will be outside of the scope of UK inheritance tax;
- In either case, where a non-UK domiciliary has been UK resident for at least 15 out of the last 20 tax years, it will be taxed as a UK domiciliary;
- For a non-UK investor in UK real estate, rental income will remain chargeable either to corporation tax (if owned by a company) or income tax (if owned by an individual or trustee). Tax is withheld at source unless the landlord registers with HM Revenue & Customs under the non-resident landlord scheme;
- UK real estate owned directly by an individual or a trust will be within the scope of UK inheritance tax. UK residential property owned indirectly by an individual or a trust will remain within the scope of UK inheritance tax (ie, it is not possible to use IHT ‘blocker’ planning for residential property);
- Where UK real estate is held through a UK company, there is no withholding tax on dividends from that company to non-UK resident shareholders; and
- Where UK residential property is held through a company for anything other than the purposes of property development or rental to a third-party unconnected tenant, there is an annual charge (ATED) payable on all residential property worth in excess of £500,000. There may also be employment income tax charges payable on directors or shadow-directors who occupy company-owned property rent-free.
Tax considerations on disposal
Additionally, the presenter made the following points:
- A UK-resident company will be liable to corporation tax on all profits arising on the sale of foreign real estate;
- A UK-resident individual will be liable to UK capital gains tax on disposal of non-UK property depending on their domicile;
- A UK-resident UK domiciliary will pay UK capital gains tax on the sale of any non-UK real estate, unless it is residential property which qualifies for main residence relief (for which a complex test applies);
- A UK-resident non-UK domiciliary may be able to avoid paying UK capital gains tax on the sale of non-UK property by claiming the benefit of ‘the remittance basis’ and ensuring the capital gains are not brought to the UK;
- In either case, where a non-UK domiciliary has been UK resident for at least 15 out of the last 20 tax years, it will be taxed as a UK domiciliary;
- Where UK real estate owned by a non-UK resident is sold, UK corporation tax (in the case of non-UK companies) or capital gains tax (in the case of individuals or trustees) is payable. The rate of capital gains tax in respect of residential property is 28 per cent;
- Where a company is ‘property rich’ (derives 75 per cent or more of its value from UK real estate) then gains on a disposal of such a company remain within the scope of UK corporation tax (if the disposal is by a company) or capital gains tax (if the disposal is by an individual or a trustee); and
- There are special outbound tax regimes for UK real estate investment trusts (REITs) and property authorised investment funds (PAIFs). There is no special treatment for UK resident individuals receiving distributions from entities that benefit from another jurisdiction’s special tax regime.
Special inbound tax regimes
If an investment company meets the conditions to be a UK REIT or PAIF, then special rates and special withholding treatment can apply to share acquisitions, as well as exemptions from SDLT.
If property is held by a non-UK resident subsidiary of a UK REIT, there can be an election into the UK REIT regime – the result of which is no CIT on income or on non-resident capital gains. However, there can be SDLT on acquisition of property.
There would also be no SDLT and generally no stamp duty/stamp duty reserve tax (SDRT) on acquisition of shares in a non-UK company holding UK property. Jersey or other offshore property unit trusts (JPUTs) have no UK tax on income or gains. Stamp duty land tax, including a two per cent surcharge on acquiring property, does exist for JPUTs, but there is no SDLT or SDRT on acquiring an interest in a JPUT.